Wells Fargo's growth securities linked to basket of funds target 'fairly bullish' investors

By Emma Trincal

New York, Oct. 7 - Wells Fargo & Co.'s 0% growth securities due May 2015 linked to a basket of three U.S. equity exchange-traded funds are for "the fairly bullish" investor looking for a different payout than a direct investment in the funds, said Suzi Hampson, structured products analyst at Future Value Consultants.

The underlying basket consists of the SPDR S&P 500 ETF trust with a 50% weight, the iShares Russell 2000 index fund with a 25% weight and the SPDR S&P MidCap 400 ETF trust with a 25% weight, according to a 424B2 filing with the Securities and Exchange Commission.

Bulls and cap

There is a 35% to 45% cap, which is about 12% per annum, said Hampson, assuming a 42.5% cap. With the 1.5 leverage factor, investors need a basket return of about 8% per year to maximize their return.

The downside is protected with a 15% buffer, which means that investors will receive par if the basket falls by up to 15% and will be exposed to any decline beyond 15%.

"The notes, which have a little bit of leverage but a relatively high cap, are designed for reasonably bullish investors," she said.

"If you think the underlying basket is going to grow rapidly, you don't want to be limited with a cap.

"On the other end of the spectrum, a less bullish market participant would buy the underlying basket directly. They wouldn't go for the cap."

A different payout

Unlike some commodities product based on a basket of hard-to-access commodities or indexes, this equity-linked note is not designed to offer ease of access, she said.

"The main idea for the investor in the notes compared to the equity investor here is not to gain exposure to a complex or hard-to-access asset class or securities. These are all U.S. equity benchmarks. It's quite easy to invest in this basket directly. Rather than access to anything, what they're looking for is a slightly different payout," she said.

That payout comes with a 15% downside protection and some moderate leverage, she noted.

"As long as you don't hit the cap, this payout profile will make you outperform the basket," she noted.

Compared to a direct equity investor, the notes will outperform if the basket return is negative because only 85% of the capital is at risk, she said.

The investor will either lose nothing if the decline is within the buffer range or lose less than the equity investor if the basket drops by more than 15%.

On the upside, if the underlying basket generates a gain below 8% per year, the investor in the notes will also outperform the direct investment thanks to the leverage. Above 8%, the cap is reached and the notes underperform the equity, she said.

Risk profile

Hampson emphasized that the product is far from being "not risky," as evidenced by the riskmap, a Future Value Consultants rating that measures the risk associated with a product on a scale from zero to 10.

The noted received a 4.50 riskmap, which is less than the average riskmap of all other products at 5.52 but slightly more than the average of products of the same structure, rated 4.44.

"It's not the riskiest product at the end of the spectrum. And a 15% buffer looks bigger than the average 10% you see on other products. But keep in mind that this is a three-and-a-half-year product. Because it's longer, you would expect more protection. The 15% buffer doesn't make it the safest note in this category of products," she said.

The riskmap compares the average product underperformance (relative to cash) with the average underperformance of five sample assets of different volatility levels. The risk rating equates the risk of the products against the five hypothetical assets.

The rating is made up of a market riskmap and a credit riskmap.

For this product, market risk is where most of the risk comes from, she said.

"The majority of the probability if you lose capital comes from the market risk. It's more likely that the basket will go down than that Wells Fargo will default" she said.

In fact, she noted, the credit risk associated with this issuer is relatively moderate compared to other names based on Wells Fargo's credit default swap spread of 151 basis points.

"It's quite low compared to a lot of the others. I think a lot of the credit risk here is attributable to duration," she said.

The notes are less risky than the average of all products because the broad category includes structures such as reverse convertibles that outnumber other types of products.

"The average riskmap of 5.52 is pushed up with the risky reverse convertibles," she said.

"If the 4.5 riskmap doesn't seem like much, you still have quite a good probability of losing some capital."

Probabilities of losses

She referred to the probability of return outcomes calculated by Future Value Consultants from a Monte Carlo simulation and displayed in a chart across different return buckets.

For this product, investors have a roughly 40% chance of losing capital against 60% of making money, the table shows.

The greatest probabilities are on the "extreme" buckets: a 15% chance of losing more than 15% of capital and a 41.5% probability of generating a gain comprised between 5% and 10% per year.

The return score, at 7.05, is above the 6.06 average return score of all products.

The return score is Future Value Consultants' opinion of the risk-adjusted return calculated from five key assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. Future Value Consultants calculates a risk-adjusted average return for each assumption. The return score is the best of these five returns.

"It's a good return score due to a combination of factors. The cap is quite high and you're getting some leveraged return," Hampson said.

"You outperform the basket unless you hit the cap, and you outperform the basket on the downside."

Price, overall

The notes have a price score of 6.02. The rating is Future Value Consultants' estimate of the total costs taken out of the product from direct fees and profit margin on the underlying derivative.

"This is an average price score compared to all other products, but it's less than products of the same type," she said.

"It still suggests that the issuer spent a decent amount on the options. You want them to spend more on the options in order to provide investors with more value."

The overall score, Future Value Consultants' opinion on the quality of a deal based on the average of the price score and the return score, is 6.54 for the product. The score is more than the average of all products at 5.97 but less than similar products at 7.11.

"The price score seems to bring down the overall in this case, but the exact terms have not been set yet," she said.

The exact cap will be set at pricing.

"When the cap settles, it might change depending on volatility levels," she noted.

Wells Fargo Securities, LLC is the agent.

The notes will settle in November.

The Cusip number is 94986RFY2.

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